US Corporations Only Paid 13% Of Their Profits In Federal Tax: Apple Is The Explanation For This

There's a new report out from the GAO pointing out that, by their measure, US corporations only paid 13% of their profits in the Federal corporate income tax. Instead of the 35% headline rate. This has caused some huffing and puffing from the Tax Foundation: essentially, arguing with their method of measurement. However, there's a really very simple method indeed to explain why the disparity between the numbers. We can see it just by looking at what
Apple does with its tax burdens and extrapolate that a little bit to other large US companies with substantial overseas operations.

For tax year 2010, profitable Schedule M-3 filers actually paid U.S. federal income taxes amounting to 12.6 percent of the worldwide income that they reported in their financial statements (for those entities included in their tax returns). This tax rate is slightly lower than the 13.1 percent rate based on the current federal tax expenses that they reported in those financial statements; it is significantly lower than the 21 percent effective rate based on actual taxes and taxable income, which itself is well below the top statutory rate of 35 percent. 19

The relatively low federal effective tax rate cannot be explained by income taxes paid to other countries. Even when foreign, state, and local corporate income taxes are included in the numerator, for tax year 2010, profitable Schedule M-3 filers actually paid income taxes amounting to 16.9 percent of their reported worldwide income.

OK, we know what happens next. Angry Senators appearing on TV shouting about the tax dodging !**!~~'s. And to be fair, there is indeed a rather large difference between the effective rates, the rates actually paid, and that headline rate. Although we should also be fair and point out that the difference is entirely a result of the laws that those Senators have passed: absolutely no one at all here is claiming any illegality on the part of the corporations. All of this is 100% legal: so it must be down to provisions in the law.

So how did GAO come up with such a low effective tax rate? Mainly by comparing apples and oranges. Particularly, GAO takes the smallest measure of taxes paid and divides it by the largest measure of net income according to financial statements, even though this net income is not the tax base that the corporate tax was meant to apply to. The corporate tax rate applies to taxable income, as defined in the tax code. According to GAO, taxable income in 2010 was $863 billion for profitable corporations, while financial statement income was $1.443 trillion. The difference between taxable income and financial statement income varies from year to year due to timing differences in the treatment of cost recovery and losses, temporary tax provisions, etc. Other researchers who use financial statement data account for these differences in various ways and they generally find corporate ETRs of about 26 percent. GAO’s ratio of 12.6 percent simply does not take these differences into account.

I'll leave it up to you to decide who you want to support in that little spat.

However, there's a much simpler method of identifying why the tax rate is so low. We can see it in the results from Apple and the same behaviour, to a greater or lesser extent, is common among the tech giants (
Microsoft,
Facebook and
Google certainly use it) and so too do large US companies in other lines of business if they have substantial overseas operations.

The point is in the detail of what the GAO is measuring. In fact, I would argue that what the GAO is measuring is itself a flawed measure. They are looking at total profits made by US corporations and comparing it with the total Federal corporate income tax paid: or in their later measure, total corporate income tax paid globally. But corporations do not owe the US corporate income tax on all of their profits. They simply don't: they owe it, in full, on profits made in the US plus on profits made abroad which are then remitted to the US, minus the foreign corporate incomes taxes already paid. Profits made abroad and not remitted are not subject (with a couple of small caveats) to the US corporate income tax.

Thus, measuring the US corporate income tax against total US corporate profits is simply the wrong thing to be doing. That tax is not due on all of that money. So why set up a system of measurement which implicitly assumes that it is?

We can see the effects of this with a quick glance at Apple's tax payments. They pay full US corporate income tax on their profits made inside the USA. As Tim Cook has repeatedly pointed out, they don't play any games with that. They've got their foreign business organised so that all of the profit piles up in Ireland. Ireland only charges the corporate income tax to profits made from economic activity in that country: thus the vast majority of Apple's overseas profits go almost entirely untaxed. Their annual report has said that the average rate is around 2% only. Apple does not remit that money into the US: so, it's not charged the US corporate income tax. And just this one company has substantial sums sheltered in this manner: they've a cash pile of well over $100 billion sitting around after only a few years of doing this. Add in that we know that the other tech giants, in fact almost all US corporates with substantial overseas operations, do exactly the same thing and our "tax gap" is explained. Estimates vary but something between $1.3 and $1.7 trillion is sitting offshore as a result of corporations doing this.

These are sums large enough to explain a great deal of those gaps in the GAO's figures. And it comes down to what the GAO is using as its system of measurement. They're using the 35% rate, that headline rate, and comparing tax paid against it. But overseas profits that are never remitted to the US are not subject to that 35% rate. So it's really the wrong number to be using. And given that they're not using the correct number then obviously their results are at variance with everyone else's.